Wachovia's decision to jilt Citigroup at the altar and merge with Wells Fargo is turning into a high-stakes legal drama, but the outcome could have interesting implications for the institutional and retail brokerage business.Back in 2005, Wells Fargo exited the institutional equity brokerage and research business because of the buy-side shift to electronic trading, the overall decline in commission rates and because the business didn't not align with its middle-market and corporate customer focus. Ironically. if Wells Fargo pulls off the merger with Wachovia it could be resuming the very institutional equity trading business it left. (However, Wells Fargo continued to operate its fixed income institutional brokerage business through Wells Fargo Institutional Brokerage and Sales, which traded $20 billion in fixed income and other securities daily through 100 registered brokers.)
Though Wachovia Securities is not a large player in U.S. institutional equity trading, according to Sang Lee, managing partner at Aite Group, Wachovia uses the SunGard Brass order management system on its trading desk, so that is a piece of technology that Wells Fargo will inherit. Perusing Advanced Trading's Algorithmic Trading Directory, I learned that Wachovia provides WATS - Wachovia Automated Trading Solutions, a full suite of algorithms. Though it's not clear whether WATS was developed inhouse or was white labeled from another firm, I have learned that WATS was developed internally in 2004 by the WATS team and currently operates within Wachovia Capital Markets.
Wachovia also has a fixed income derivatives trading operation. I visited Wachovia's New York corporate and investment bank about two years ago. At that time, Wachovia's CTO Susan Certoma had recently arrived from Goldman Sachs. We talked about Wachovia's use of grid computing to price fixed-income derivatives and to reduce power consumption. We were took a tour of Wachovia's data center to see the racks of servers that powered the floor. Since the new trend was going to be cross-asset trading platforms, Wachovia was moving people into trading pods to seat the cash traders next to the derivatives traders so they could learn from each other.
Wachovia was a large underwriter of CMBS (commercial mortgage backed securities), and had a derivatives book associated with that, said John Jay, a senior analyst with Aite Group in an interview on Friday. "Whether Citi or Wells Fargo acquires Wachovia, they will end up with those contracts," said Jay. "In terms of counterparty risk, those were OTC derivatives," noted Jay. "Whoever those counterparties are (that are on the other side of trades with Wachovia), they will have to sort that out what is going to happen with outstanding contracts," said Jay"That could be opening up a can of worms," warned the analyst, adding that includes valuation.
What is opening up an even bigger can of worms is Wachovia backing out of the sale to Citi. As everyone knows, last Monday, Wachovia, on the verge of collapse from risky mortgages, agreed to be purchased by Citi to avoid a takeover by the Federal Deposit Insurance Corporation (FDIC). Citi wanted to shore up its deposit base, but was not buying any of the brokerage or asset management operations. Then on Thursday night, Wachovia's CEO Robert Steel evidently called off the marriage and woke up Citi's CEO Vikram Pandit at 2:00 am to deliver the bad news. In fact, one of the reasons why Wachovia may have jilted Citigroup at the altar is that Citi's $2.1 billion takeover (which involves government guarantees against losses) did not include Wachovia Securities or Evergreen Investments, whereas Wells Fargo's deal includes both the securities and asset manager operations.
If the acquistiion materializes, Wells Fargo will get a powerhouse in retail brokerage in that Wachovia acquired A.G. Edwards, the St. Louis-based retail brokerage firm in May of 2007 for $8.6 billion in cash and stock. If Wells Fargo buys Wachovia, it will get Wachovia 3,300 brokerage locations, more than $1.1 trillion in assets and close to 15,000 financial advisers, which could help it compete with the likes of the Bank of America-Merrill Lynch combination. Since Citi owns Smith Barney, and already has an institutional broker, perhaps it didn't want Wachovia's securities business. Meanwhile, the legal battle rages and the FDIC may end up dividing up Wachovia's branches along regional lines to satisfy the suitors.Ironically. if Wells Fargo pulls off the merger with Wachovia it could be resuming the very institutional equity trading business it left. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio